Many people have been working from home due to the pandemic, but only certain people will qualify to claim the home office deduction. This deduction allows qualifying you to deduct certain home expenses on their tax return when they file their 2021 tax return next year.
The most important thing to note is that employees are not eligible to claim the home office deduction. This applies to ALL employees (including S corporation owners who also serve as employees of those companies). If you are an owner of an S-Corp read the section on accountability plans below.
The term “home” for purposes of this deduction:
1. Includes a house, apartment, condominium, mobile home, boat or similar property which provide basic living accommodations.
2. Any portion of a home used exclusively as a hotel, motel, inn or similar establishment does NOT qualify as a “home” and, therefore, does not qualify for a home office deduction.
Generally, there are two basic requirements for the taxpayer’s home to qualify as a deduction:
1. There must be exclusive use of a portion of the home for conducting business on a regular basis. For example, a taxpayer who uses an extra room to run their business can take a home office deduction only for that extra room so long as it is used both regularly and exclusively in the business.
2. The home must be the taxpayer’s principal place of business. A taxpayer can also meet this requirement if administrative or management activities are conducted at the home and there is no other location to perform these duties. Therefore, someone who conducts business outside of their home but also uses their home to conduct business may still qualify for a home office deduction.
3. A portion of a home that is used exclusively for conducting business on a regular basis but not used as the principal place of business, will qualify for a home office deduction if either patients, clients or customers are met in the home or there is a separate structure that is used exclusively for conducting business on a regular basis.
Taxpayers who qualify may choose one of two methods to calculate their home office expense deduction
1. Using the simplified method consisting of a rate of $5 per square foot for business use of the home which is limited to a maximum size of 300 square feet and a maximum deduction $1,500.
2. Using the regular method whereby deductions for a home office are based on the percentage of the home devoted to business use. Any use a whole room or part of a room for conducting their business will involve figuring out the percentage of the home used for business activities to deduct indirect expenses. Direct expenses include There are certain expenses taxpayers can deduct. They include mortgage interest, insurance, utilities, repairs, maintenance, depreciation and rent.
The good news for S corporation owner-employees is that, by implementing an “Accountable Plan” a (a reimbursement program which meets certain IRS regulations), S Corporation owner-employees can continue to deduct business expenses that they pay for personally by “passing” them along to the business.
Essentially, an Accountable Plan is an IRS-approved reimbursement program that allows a business to reimburse employees for business expenses they incur as part of their work. The business is then able to deduct those reimbursed amounts as if the business had incurred the initial expense, itself. When using an Accountable Plan, reimbursements for business expenses are not considered compensation to employees thus, don’t increase payroll taxes due on wages or an employee’s income tax liability.
There are three simple guidelines an Accountable Plan must follow to be considered valid:
1. all expenses to be reimbursed through the plan must have a business connection.
2. expenses must be “timely substantiated,” and
3. any excess advances provided to the employee must be “timely repaid.” While the actual definition of “timely” is somewhat ambiguous, the IRS has provided several “safe harbor” options.
Since Accountable Plans are so simple to establish, and since they offer such flexible rules around to whom they can apply, and to which expenses they will cover, there is generally no reason for most S Corporations not to implement them.
Despite their simplicity, though, business owners should understand that if the IRS does not deem their plan in compliance with the Accountable Plan rules, their plan will be treated instead as a “Non-Accountable Plan”. In such instances, any reimbursements will be added the employee’s wages. Even though employee wages reduce gross business revenue, that reduction is offset by the increase in wages. And to top it off, the impact of higher FICA taxes as a result of those wages means that the total tax liability will be higher than if the expense hadn’t been reimbursed in the first place!
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